The role of stock-based compensation and the internal control of the firm

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This research considers the role of stock-based compensation-such as stock options and restricted stock granted to employees, and cross-shareholdings or shareholdings made in joint ventures-in mitigating the moral hazard problem that occurs when agents working in teams face the possibility of turnover and must choose a level of effort or investment in their working relationships with the other agents. In cases of both exogenous and endogenous turnover, I formally derive situations in which stock-based compensation is a component of an optimal compensation contract, and in particular, in which stock-based compensation is superior to cash-based compensation such as bonuses and severance payments. In addition, I show that stock-based compensation is not optimal for individual production. The results provide new empirical and practical implications for stock-based compensation from the viewpoint of team incentives and agents' turnover.